Negotiations to establish a new multilateral defence bank began in Montreal on Monday.Graham Hughes/The Canadian Press
Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.
This week, Montreal is hosting negotiations for a new multilateral financial institution, the Defence, Security and Resilience Bank. The aim of the DSRB would be to offer stable and affordable financing for defence-related projects as rearmament is once again becoming the norm. Establishing the bank is a good idea, but it is important to be clear-eyed about what Canada is getting out of it.
The DSRB claims that it will offer “long-term, low-cost financing without adding pressure to national balance sheets.” But it still needs to be funded by those national balance sheets. For Canada, it is unlikely that borrowing through a new multilateral institution could offer cheaper financing than it currently gets.
The logic of borrowing through the DSRB is that the bank can get lower interest rates by pooling the default risk of borrowing countries, get preferred-creditor status and benefit from institutional scale. For example, France itself may default on defence loans so investors charge a higher interest rate to lend for those projects. By contrast, the DSRB could borrow at a lower group rate because its default risk is diversified across many member countries. If France were to instead borrow through the DSRB, the bank could then pass its savings on to France. This works since the DSRB’s objective is not to earn the spread on returns but rather to finance defence spending.
But Canada is one of the most fiscally frugal of the advanced economies by net debt-to-GDP and it has never defaulted. As such, Canada’s debt is already rated AAA by S&P Global and Canadian bond yields are already among the lowest in the G20. We are beaten only by the famously thrifty Germany, and by Japan and China, which also benefit from extremely low inflation and high savings rates. It would be hard for Canada to borrow much more cheaply from the DSRB than from international investors.
Montreal to host 18 countries for defence bank negotiations beginning Monday
Of course, the DSRB could offer borrowing terms even better than those implied by diversification and institutional structure. But this can only happen if member countries, such as Canada, are willing to subsidize that credit. Thus any “cheaper” borrowing that Canada would be getting from the DSRB would ultimately be paid for by Canada itself, or other key members. This is especially likely given that Canada is taking a lead in the bank’s establishment and that its borrowing terms are among the best. In other words, this is just spending taxpayer money with extra steps.
Buying in bulk could provide another possible economic benefit. The reasoning goes: If Canada and Spain both want to pay for similar aircraft, the companies manufacturing the aircraft can sell at a lower unit price to both because they get a large, guaranteed order. This effect is what economists call “economies of scale,” where producing larger quantities can sometimes reduce the marginal cost of each unit. By offering a place to co-ordinate such joint procurement, the DSRB could in theory save its member countries money.
But here, too, the gains are uncertain. In practice, different organizations have very different requirements for their military purchases, and the costs of co-ordinating these can erode or even eliminate any savings.
For example, in the early 2000s, the U.S. Air Force, Navy and Marine Corps, alongside international partners, started a joint program to develop and procure the Lockheed Martin F-35 Joint Strike Fighter. The motivation was much the same – cut down on duplicate tasks and benefit from economies of scale. But a RAND Corporation study on this program and similar ones found that they did not offer savings relative to programs designed for specific branches of the military. The study pointed out that accommodating the design needs of multiple stakeholders often caused costs to balloon. In other words, they might have been just as well off procuring their own fighters.
What Canada does stand to gain from the establishment of the DSRB is political in nature. A leading role at a new multilateral institution would give us an influential seat at the table for global defence co-ordination. The DSRB can extend the reach of Canadian foreign policy by funding projects that serve our interests under a multilateral umbrella. Subsidies from Canada buy goodwill from our allies. A leadership role would allow us to influence global priorities by setting key agendas and give us an easy platform to build coalitions geared toward our objectives. Headquartering the bank in Canada would help define a Canadian city as a centre of global policy.
Together, these gains are worth the price of entry. But we should be sober about the economics.